Costs orders, obstacles and barriers to the derivative action under section 165 of the Companies Act 71 of 2008 (Part 1)

• Jurisdiction: South Africa
• Date: 25 May 2019
• Citation: (2014) 26 SA Merc LJ 1
• Author: Maleka Femida Cassim
• Pages: 1-23
• Published date: 25 May 2019

Articles

COSTS ORDERS, OBSTACLES AND BARRIERS

TO THE DERIVATIVE ACTION UNDER

SECTION 165 OF THE COMPANIES ACT 71

OF 2008 (PART 1)

MALEKA FEMIDA CASSIM*

Senior Lecturer, Department of Mercantile Law, University of Pretoria

INTRODUCTION

The greatest impediment to a derivative action by minority shareholders

arises from the practical barriers to the commencement of derivative

proceedings. The chief barriers are, f‌irst, the risk of the minority

shareholder being burdened with liability for the costs of the derivative

proceedings and, secondly, the lack of access to corporate information.

As long ago as 1970 the Van Wyk De Vries Commission of Inquiry into

the Companies Act

1

declared that one of the worst anomalies of the

derivative action is the risk of the plaintiff shareholder having to bear

the costs of an action in which he is ‘in effect not the real plaintiff’. In the

light of this progressive and enlightened f‌inding, it is disappointing that

the legislature has failed to adopt a more resolute approach under the

Companies Act 71 of 2008 (‘the Act’) to the vexed issue of costs. If

the new liberalised derivative action is to be a success, the courts must

face this obstacle head on. It is vital that the remedy is not unwittingly

suffocated by the courts, through the imposition of adverse costs orders

on shareholder litigants.

A functional derivative action is essential to a sound system of

corporate law. The rationale of the derivative action is explained in

paragraph I of this article. Paragraph I also addresses concerns about

shareholder abuse, and the exaggerated fears that the new statutory

*MBBCh (cum laude) LLB (cum laude) LLM (cum laude) (Wits). Senior Lecturer,

Department of Mercantile Law, University of Pretoria. Attorney and Notary Public of the

High Court of South Africa.

1

Main Report (RP 45 of 1970) para 42.12; see also ‘Company Law for the 21st Century’

Government Gazette 26493 of 23 June 2004 para 2.2.2.

1

(2014) 26 SA Merc LJ 1

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derivative action may open the f‌loodgates to shareholder litigation, thus

causing directors to f‌lee the board. In paragraph II, costs orders are

discussed, and a framework is proposed for the exercise of the judicial

discretion to make orders of costs. Guidelines from other jurisdictions,

as well as traps and pitfalls to be avoided by the South African courts in

making costs orders, are discussed in paragraph III. Reference is made to

the legal position in other common-law jurisdictions, specif‌ically Aus-

tralia, Canada, New Zealand and the United Kingdom, and the approach

in the United States of America. Paragraph IV addresses the indemnif‌i-

cation and insurance of directors who are defendants in derivative

actions. Finally, paragraph V deals brief‌ly with the minority sharehold-

er’s hurdle of obtaining access to inside corporate information, which

usually lies in the hands of the wrongdoers.

I FOUNDATIONAL POLICIES AND PRINCIPLES

(a) Rationale of the derivative action

The derivative action is designed, f‌irst, as a remedial device by which

shareholders

2

may enforce rights or recover compensation for the

company when the board of directors refuses to do so and, secondly, as a

deterrent device to prevent management abuse and to ensure control

over the board by allowing shareholders and others to litigate against

directors who have breached their f‌iduciary duties to the company.

3

The

dual objectives of the statutory derivative action have been widely

recognised. In the United States, the court in Diamond v Oreamuno

4

proclaimed that the purpose of the derivative suit is not merely to

compensate the company, but also to deter. The derivative action is

generally considered in the United States to be the ‘chief regulator of

corporate management’,

5

for it promotes accountability by directors

and managers. Recognition was also given to this deterrent objective of

2

And other applicants with standing under s 165(2) of the Act. For the purpose of

convenience, this article refers mainly to shareholder applicants. However, most of the

submissions made in this article apply equally to other applicants with locus standi under

s 165.

3

Richardson Greenshields of Canada Ltd v Kalmacoff (1995) 18 BLR (2d) 197 (CA) 205. The

Canadian legislation relating to the statutory derivative action inspired the approach in

Australian, New Zealand and Singaporean law, among others. These Commonwealth models

have exercised a strong inf‌luence on the South African statutory derivative action. The

statutory derivative action in the South African Act has also been inf‌luenced by US law.

The jurisprudence of these jurisdictions is accordingly relevant in the South African context.

See also s 5(2) of the Act. See further para III below.

4

NY 2d 494, 248 NE 2d 910, 301 NYS 2d 78 (1969).

5

Cohen v Beneficial Industrial Loan Corp, 337 US 541 (1949).

(2014) 26 SA MERC LJ2

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